DBRS Correction: DBRS Confirms Spain’s AA Ratings; Trend now Negative on Increased Downside Risks

DBRS has issued a correction to the Kingdom of Spain press release it issued on 17 August 2011. The corrected version is as follows:

DBRS Inc. (DBRS) has today confirmed the ratings of the Kingdom of Spain’s long-term foreign and local currency debt at AA and changed the trend from Stable to Negative.

The ratings balance Spain’s relatively low public-sector indebtedness and its progress in achieving its fiscal targets with high fiscal deficits, high unemployment, a fragile recovery and a weakened financial sector. The Negative trends reflect the potentially adverse effects of the sharp rise in uncertainty in financial markets on economy-wide funding conditions, and the increased risks to the growth outlook of the United States that could affect both Europe’s and Spain’s export-based recovery. This concern goes beyond the direct trade link between the United States and Spain, which is limited, as there may be more widespread consequences on growth and trade in Europe.

DBRS recognises the progress that Spain has achieved to date, with a fiscal adjustment program that is on track, ongoing reform of the savings bank sector and a narrowing of the current account deficit. Furthermore, Spain’s general government indebtedness is comparatively low. The European Commission forecasts that debt-to-GDP will rise to 68.1% by the end of 2011, which is approximately 15% of GDP below its forecasts for the three largest AAA-rated European economies: France, Germany and the United Kingdom.

As financial market concerns over debt and fiscal deficits continue, Spain and Italy have come under renewed market stress. However, European Central Bank (ECB) purchases in secondary bond markets appear to have lowered yields significantly. If these support measures continue, they could ease market pressure on sovereign funding costs and domestic financing conditions. However, the increased risks to the U.S. economic outlook could add downside risks to Spain’s recovery, given its reliance on exports. This, in turn, could make achieving fiscal targets more difficult.

At the root of Spain’s problems are losses in price-competitiveness combined with a rapid rise in leverage, which fuelled Spain’s residential property boom. A large unlisted savings banking sector, accounting for 40% of banking assets, which lent heavily to real estate, coupled with a labour market that performed poorly with losses of almost 11% of employment since the peak in the second quarter of 2008, reveal serious weaknesses. As a result, the unemployment rate has reached 20.9% and is the highest among advanced economies. Banking sector-wide non-performing loans have climbed to 6.5%, driven by exposures to construction and real estate activities, which are responsible for 52.9% of these, according to the Bank of Spain. The savings banks have also approximately EUR 44 billion, or 4.1% of GDP, in foreclosed assets. Still, there has been a substantial recognition of impairment losses in commercial and savings banks, amounting to 9% of GDP, of which 5% of GDP corresponds to the savings banks.

In spite of these shortcomings, the unwinding of economy-wide imbalances is proceeding at varying speeds. The current account balance narrowed from a deficit of 10% of GDP in 2007 to a deficit of 4.5% of GDP in 2010 as investment in residential housing declined. Exports have recovered strongly, helping to reduce the trade deficit. The contraction in construction employment has been fast and deep, accounting for 1.24 million of a total of 2.09 million jobs lost since the first quarter of 2008. Correction of house prices has reached almost 17% in nominal terms and 22% in real terms since peaking in the first quarter of 2008.

Consensus estimates place growth in 2011 at a modest 0.8%, driven by exports. With the unemployment rate at 20.9%, the depth of the recession suggests that many of the jobs lost were low productivity jobs, especially in construction. In spite of some progress in reforming labour market policies, structural unemployment is likely to have increased and, at this growth rate, it is expected that cyclical unemployment will fall slowly.

Credible debt stabilisation by 2013 in an environment of increased risk aversion, and with modest near-term growth prospects, will continue to require a persistent policy effort, especially with respect to potential slippages by some Autonomous Communities. President Rodríguez Zapatero has called early elections for 20 November 2011, and opinion polls give the opposition People’s Party a substantial lead over the ruling Socialist Party. Regardless of the outcome, there is a widespread political consensus on the need for fiscal consolidation, and DBRS expects that the firm commitment to the fiscal adjustment programme will continue.

DBRS could change the trend from Negative to Stable if there is a material reduction in downside risks to the growth outlook of advanced economies, along with more stable financial markets, or if Spain’s growth outlook improves. However, downward rating actions could be triggered by significant fiscal slippage, a worsening of growth prospects or if access to funding were to deteriorate materially.

Notes:
All figures are in Euros (EUR) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies.

The sources of information used for this rating include the National Statistical Institute, The Bank of Spain, Eurostat and the International Monetary Fund. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited rating. This rating is based solely on publicly available information.

Lead Analyst: Pedro Auger
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 21 October 2010
Most Recent Rating Update: 21 October 2010

For additional information on this rating please refer to the linking document under Related Research.